Demographics, house prices and mortgage design

Published 23/03/2012

I had planned to talk about the budget today but for one thing everyone’s at it and for another, aside from the 15% rate on those attempting to dodge stamp duty by buying through a company plus retrospective hits for anyone weaselling out of that (got my inner leftie popping the cork on a bottle of People’s Sparkling Turnip Wine, I can tell you), there was little of interest from a mortgage point of view. I suspect the 7% rate will be largely greeted with a big “meh” from anyone not buying a shoe box in Knightsbridge.

So instead let’s have a look at a little-covered paper by David Miles, he of Monetary Policy Committee fame, modelling future UK demographics and the likely impact on housing and mortgages. It’s a fascinating piece, if you like that sort of thing.

I don’t propose critique his model (as if!) but the route is fairly detailed and plausible. The nub of the argument is that as population density increases (we’re forecast to overtake Japan by about 2040) it has an ever-greater impact on housing supply and prices, and the standard means of financing house purchase (mortgages, to you and me) becomes progressively less viable. As Miles didn’t say, they ain’t makin’ any more land.

The supply and demand implication is obvious: “In this model it is likely that, as density rises, house prices eventually come to rise faster than incomes.” Ring any bells? The prospect of ever-increasing (and accelerating) house price growth will cheer the Daily Mail set, fire outrage in the housepricecrashistas, and flies in the face of recent experience – but then we are living in interesting times. What interests me though, is the next step he takes regarding finance.

As prices outstrip incomes, buyers need ever bigger deposits, but that isn’t going to work because the required deposits will grow faster than the incomes to support them. As an alternative Miles looks to shared equity: a third party provides an equity loan as part of the deposit and in return takes a share of the growth in value. So I lend you £10,000 to help buy your £100,000 first home. When you sell I get my £10k back plus 20% of your equity growth. Conversely if prices fall I share the hit (though being a good capitalist I’ll only take a 10% loss).

Miles examines what’s needed for a decent balance of risk and return for the equity lender. He finds a wide range of options that could work under his model – from the equity lender taking 36% of growth and none of any loss, to 64% of growth and 100% of loss. But strikingly he spends almost no time on what it means for the home owner – he simply envisages the buyer making the same sort of enlightened risk / return decision as the equity lender. Never mind that the average first time buyer’s judgement is likely to be somewhat less sophisticated than the institutional investor, this strikes me as missing a huge consideration.

Let’s say in the above example, you had put in 5% deposit alongside the 10% equity loan. So your mortgage was £85,000. If you sell at £125,000, instead of £40,000 equity you only have £25,000 – the other £15k being my original £10k loan and my £5k share of your equity growth. That could have a serious impact on your next house purchase: either restricting the property choice you can make, or pushing you to another equity loan. And, another after that, and another after that. Potentially the true price of that initial £10,000 loan is sacrificing equity for the rest of your life.

It’s easy to see how shared equity could become self-perpetuating and, as some have suggested, the norm. If you have less equity you can’t, for example, give it to your kids to help them by a house – so they have to take an equity loan too. But I can’t help thinking (and this is just a personal view ) that this, along with the myriad other “alternative purchase” methods, are fundamentally kicking the real issue into the long grass – the fact that housing is simply too expensive.

David Miles believes that over the long term population growth means this will only get worse. But you have to wonder whether shared equity schemes would really address that in a way that works for the consumer, and what other prices there may be to pay. I don’t want to sound alarmist but an “equity crunch” would be all too easy to envisage if the Masters Of The Universe decided it’s the next big wheeze. To be fair, I don’t think Miles is suggesting shared equity is a silver bullet – which is probably just as well.

Clearly in our example, without the equity loan, you wouldn’t have bought a property at all – or not yet. But perhaps (say it quietly) that isn’t the bogeyman many would have us believe. What we really need is a decent period of stable or low growth in housing costs while income catches up. And if there’s any upside to the current ghastliness of restricted availability and low activity, it’s that this seems to be happening – albeit very, very slowly.

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